In the latest update from the Strategic Fixed Income desk, Co-Head, Jenna Barnard shares her views on the current environment for corporate bond investing.
Much has been written about the European Central Bank (ECB) and Bank of England’s purchases of investment grade corporate and government bonds, and the significant positive impact this has had on those markets. John and I have also discussed at length, the unwillingness of UK and European investment grade companies to take advantage of the resulting low bond yields in order to increase leverage. This is in contrast to US companies, which have been binging on ‘cheap’ debt, particularly in sectors like technology and healthcare.
As we have stated previously, we think European companies are following the Japanese playbook following a credit crisis, which resulted in an aversion to debt. The relatively conservative stance of European companies is a supportive backdrop for European bond investors. The one notable exception to date is Bayer’s aggressive proposed acquisition of Monsanto but we feel that this remains an outlier. US investment grade bond issuance has been interesting to us in a select number of companies that have leveraged up and have a credible deleveraging strategy. Europe, we feel, has a more defensive backdrop of generally conservative management teams – it is worth noting we often buy European company bonds denominated in US dollars for valuation reasons.
Notable shift in European high yield
The technical dynamic in the European high yield market has also been extremely positive for investors and worthy of comment. The higher credit risk high yield market is not subject to central bank quantitative easing schemes and hence the ECB and Bank of England are not buying these bonds.
However, there is a distinct lack of bond issuance in this market, which has had a pronounced effect on market technicals. Year-to-date, the European high yield bond market has actually shrunk with net issuance running at approximately -€1bn, and close to -€10bn with coupon payments to investors included*. The market is approximately €318bn in size and annual net issuance since 2009 has run at €15-30bn*. Hence the shift to a shrinking of the market in 2016 is noteworthy. It also comes at a time when the yield on the European high yield index has fallen to an all-time low of 3.4%; meaning the cost of debt is exceptionally cheap for these companies.
Again, we think this reflects a number of factors, including companies not wanting to leverage themselves up aggressively (as explained above) and a lack of private equity activity, given the high valuations in public markets and the mess they made binging on debt in 2005-07.
In summary we remain alert to any shifts in corporate behaviour from European companies. However, the example of the European high yield market failing to grow in 2016 adds to the evidence of Europe following in Japan’s footsteps. In other words, this is a behavioural reaction to the ‘balance sheet recession’ that we have talked so much about in the past.
*Source: Deutsche Bank, 19 August 2016